Most financial advice we get is based on the premise that our post-retirement income will be less than pre-retirement income, and many of us do make less in our senior years.
The RRSP is a great savings vehicle that provides financial incentives to contribute. The deductions defer the income tax we must pay to a later date and this suits many people well.
The impact of taxes on retirement income is an important consideration. The conventional wisdom is to wait as long as possible before withdrawing from RRSP/RRIFs to put off paying taxes as long as possible.
However, seniors who defer RRSP/RRIFs withdrawals until after age 71 can be pushed into a higher tax bracket when the mandatory withdrawals are put into play (and increase each year).
Making withdrawals earlier to smooth out income from year to year makes it work more tax efficiently.
Taxable income is used to determine the amount of federal and provincial taxes payable. We have a progressive tax system, which means that your tax rate becomes higher as your taxable income increases.
The first three levels of the federal tax rates for 2015 are as follows:
- $0 – $11,327 = 0%
- $11,327.01 – 44,701 = 15%
- $44,701.01 – 89,401 = 22%
Provinces have their own rates and may also have more brackets.
Your marginal tax rate is significant in tax planning because it represents the highest rate of tax you pay on your income at that level.
Net income is important as it used to calculate income-tested benefits such as OAS and non-refundable tax credits such as the Age Credit, as well as provincial health care and drug programs, and social supports.
Related: Create your retirement income plan
The RRSP/RRIF withdrawal strategy here is designed to reduce taxes and clawbacks by moving income out of the higher tax bracket one may find themselves in as a result of mandatory withdrawals after age 71, and equalizing income.
The goal is to strategically melt down existing RRSPs by withdrawing money up to the top of your current federal tax bracket over a period of years to smooth out taxable income from year to year, even if it’s not needed for cash flow.
It’s better to withdraw earlier even if you have to pay tax on the withdrawals. If you don’t need the money, transfer it to a TFSA for further tax-exempt growth.
This strategy is effective for early retirees (before age 65). It might pay off in the long run because it doesn’t erode the Age Credit and OAS benefits.
Lower income seniors
Most low-income adults are eligible for GIS payments, a means tested program. For those who have saved in RRSPs each $1 withdrawn results in a clawback of 50 cents from GIS – equivalent to a 50% marginal tax rate.
People with lower incomes should draw down their RRSPs before age 65 so the GIS remains intact or little changed.
Taxes represent one of the largest personal expenses a retiree may have. I believe that we should use any legitimate strategies available to us to reduce tax payments, especially when it comes to our life savings. Our retirement nest egg can also become the CRA’s nest egg.
The current retirement income system serves the vast majority of Canadians very well. Make an effort to make it tax efficient also by determining the right drawdown strategy for your personal situation.